Sale-leasebacks can play a role in easing fiscal woes, but shouldn't replace budget cutting and government streamlining

Arizona has made national headlines in recent months for a $735 million dollar proposal to sell state buildings to generate revenue in the face of ongoing, massive budget deficits. Given their high-profile nature, the inclusion of the state House and Senate buildings, the Governor’s executive tower and state prisons in the package has generated a great deal of publicity, generating headlines like “Desperate state may sell Capitol buildings, others” in the Arizona Republic and even a Daily Show segment poking fun at the idea.

But Arizona’s not alone. California policymakers recently announced a similar $2 billion initiative that includes a number of state office buildings in Sacramento. With dozens of states facing severe and widespread budget woes it’s only a matter of time before similar proposals begin proliferating, so it’s worth examining what these asset sales are and what they are not.

It’s important to understand that these states are not “selling” assets in the pure sense of the term. In Arizona, the recently-enacted budget facilitates the sale and leaseback of dozens of state buildings to generate hundreds of millions in one-time revenue to help close a looming $3 billion budget deficit. This is essentially a purely financial transaction-a mortgage, of sorts-to generate upfront cash.

The state would commit to repaying the financiers through annual lease payments and would take ownership of the buildings back at the end of a 20-year lease term. During those 20 years, the state would continue to operate, maintain and use those buildings just as they do today. Any fears about the “loss of public control” over assets would be unfounded in the types of deals Arizona is considering.

The private sector (as well as institutional investors like public pension funds) is willing to do these deals because they have the cash to invest, and government is generally viewed as a reliable tenant bringing steady income to investors with low-risk. And it obviously helps the state fill budget holes.

The question of whether this makes sense for taxpayers has a more nuanced answer. It can indeed a sensible strategy to leverage public assets to address budget deficits and invest in long-term debt reduction or infrastructure improvements. But it is how you do it that’s important, and the devil’s in the details.

Whether states are going to sell outright or pursue “sale-leasebacks,” the best and most fiscally responsible way to “spend the windfall” of a long-term transaction is to invest it for long-term economic benefit, such as paying down public debt (akin to paying down additional principal on a mortgage), shoring up underfunded public pensions, and investing in long-lived infrastructure.

However, the fiscal and political realities in many states today-and a strong desire among policymakers to avoid raising taxes-make it probable that some portion of a one-time revenue windfall to government will get spent on immediate needs like plugging budget deficits.

Chicago offers an example here, where the over $3 billion the city received from long-term leases of the Skyway toll road, four downtown parking garages and the downtown parking meter system have been used for a variety of purposes involving various time-scales, including paying down public debt, setting up rainy day funds, short- and long-term investments to augment city revenues, and short-term budget fixes. In an ideal world, one could wish for the proceeds to have been spent fully on long-term investments like infrastructure or debt reduction, but the realities of governing in a recession dictate otherwise.

Still, given a choice, many taxpayers would likely choose to have city assets leased than have their taxes raised to balance the budget, even if not all 100 percent of the revenues are dedicated to long-term uses. To their credit, Chicago’s done a relatively good job in tough circumstances balancing the short- and long-term uses of their lease proceeds.

By contrast, Arizona’s situation would have to rank near the bottom of the fiscal responsibility meter because they’re not talking about investing any of the proceeds into long-term budget reduction or investments. All the money will be spent to help close the next budget deficit, after which there will be nothing left to show for it. Put differently, all of the proceeds from a 20-year sale-leaseback will be spent in year one.

Adjusting the structure of the proposed sale-leasebacks could yield more benefits. For instance, in addition to the legal ownership of the buildings, it’s not too late for Arizona and California to consider turning over operations and maintenance to private bidders as well, a strategy that could yield tremendous cost savings over time. Otherwise, there’s no incentive for the state to maintain those buildings more efficiently than they do today.

By contrast, states like Virginia, Florida and Georgia have seen tremendous operations and maintenance cost savings for state assets using performance-based asset maintenance contracts that lock in favorable costs over a long-term (see this article for more on how this concept is being applied in road maintenance). Shifting to this type of approach would bump these proposals higher on the fiscal responsibility meter, given that it would build in a long-term savings for the state.

A deeper critique involves priorities and policy decision-making. And it should be stated upfront that the current sale-leaseback proposals are not inherently a bad idea or shouldn’t play a role. The issue is not the tool itself but how one uses it. And on that front policymakers have dropped the ball.

Instead of making politically difficult decisions on budget cuts, priorities, and core vs. non-core government functions, Arizona and California policymakers are almost abandoning fiscal responsibility and making a desperation play for quick cash. They’d deserve better marks if they were bundling in operations and maintenance and generating long-term savings (and potentially a larger upfront payment) to the state, as described above. Instead, the states will still continue to maintain the buildings the same way they do today, without the cost-savings and efficiencies that the private-sector could bring in a long-term, performance-based maintenance contracting situation.

Similarly, they’d deserve better marks if they were using some portion of the proceeds to pay down state debt, invest in short- and long-term annuities to generate supplemental revenues over a longer timeframe, highway expansions/maintenance or something with a shelf life exceeding 365 days. Instead, it’s “bye-bye, cash” in year one.

They’d also deserve better marks if they were permanently selling off parcels of underutilized state land or assets that are not central to core government functions, and there are plenty in both states. For example, California’s highly-publicized list of potential divestiture opportunities include San Quentin State Prison, the Orange County Fairgrounds and the L.A. Memorial Coliseum. Arizona likely has similar non-essential assets, as well as excess land surrounding state prisons and highways.

In the end though, even a flawed sale-leaseback program is preferable to the alternative. No one will argue that this is a desperation play. But many taxpayers would still prefer a desperation play to tax increases or taking on more bonded debt, IOUs and the like. Taxes and debt will only dig the fiscal hole deeper, and sale-leasebacks beat those approaches any day. In that light, the proposed sale-leasebacks offer a last firewall of sorts against billions in tax increases and additional public debt that would be another blow to fragile state economies.

It’s just unfortunate that it had to get to this point. What would truly be innovative would be to significantly reduce the size and scope of government, which neither state’s governors nor legislatures made any real traction on this past session. It’s long past time for policymakers to dispense with the illusion that there’s some easy and painless way to navigate the recession and start making tough, but necessary, decisions to rein in government spending.

Leonard C. Gilroy is the director of government reform at Reason Foundation.